Achieving steady growth in annual recurring revenue (ARR) is a priority goal for every company. But this is especially critical for SaaS businesses given they rely on a business model where revenue generation is linked to recurring sources of income (i.e. a subscription model). Although monthly recurring revenue (MRR) is more widely used than ARR, the latter is a useful metric if your subscription terms are one-year long or multi-year.
ARR normalises or compounds the value of term subscription agreements over a 12-month period.
The formula to calculate subscription business ARR is relatively straightforward: MRR x 12.
This calculation takes into account all recurring customer revenue, renewals, as well as expansion revenue like add-ons and upgrades that aren’t a one-off but rather drive subscription costs up.
However, the relationship between MRR and ARR isn’t always linear. By this we mean that MRR can be on or above target for a month, two, or more, but ARR revenue can still be declining on a year-on-year basis. Declining ARR revenue increases risks and vulnerability if something unexpected happens, like higher operational costs. For a subscription company, this could mean operating at a loss.
The signs of declining ARR revenue are not hard to spot: high churn rates, low customer lifetime value, and unbalanced customer acquisition costs are some of the metrics that set the alarm bells ringing. In this situation, failing to take immediate remedial action could jeopardise future business and revenue growth. In this post we’ll answer two questions related to declining ARR: how to decide what to fix and how to go about it.
Why customer retention is as important as acquisition
When faced with declining ARR numbers, some business owners may be tempted to launch costly campaigns to boost their month-to-month results (MRR) or to expand their subscriber base. But never underestimate how much revenue existing customers can bring.
The figures are pretty clear: a mere 5% rise in customer retention can increase company revenue by 25-95%. And 80% of your future revenue will come from 20% of your existing customers. This means that efforts to improve customer retention should be prioritised over customer acquisition.
There are a few reasons why customer retention is critical to company growth and success:
We’ve already established that retaining existing customers is more cost effective than acquiring new ones. Whether this strategy isn’t just affordable but also profitable (in that it brings more subscription revenue) depends on focusing on the most valuable existing clients or segments. In other words, it requires that you direct your resources to those that help generate net margin.
Existing customers are 60 to 70% more likely to convert on cross-sell or upsell campaigns than new customers, where the likelihood goes down to 5% - 20%. Not only that, but existing customers spend 31% more than new customers.
customers who know the value of a product or service don’t need to be convinced to renew or upgrade subscription term contracts – they make the organic decision to do so. And as you develop more products or services, your name will be top of mind and many of these clients won’t even consider the offerings of competitors.
Satisfied customers are likely to bring in other loyal clients. The more referrals you get, the less resources you’ll need to spend to expand your customer base. Data shows that word-of-mouth referrals can drive up to 50% of purchasing decisions. This is particularly important for companies that are bootstrapping marketing operations or struggling with cash flow issues and cannot invest in costly acquisition campaigns.
How to Diagnose the problem with your ARR
Focusing on customer retention is more profitable than acquisition, so this course of action must be prioritised for revenue growth. But if your ARR revenue is down, you’ll want to get really granular on how best to keep existing customers.
The first step is to determine where the problems or bottlenecks are. A drop in sales is rarely “just” a drop: failing to meet forecast revenue is often a sign that other aspects of business operations need adjusting. Some of the most common factors behind declining ARR include:
Poor customer-product fit
Your SaaS product may have met client needs in the past, but those needs evolve and your SaaS offer should adapt accordingly. So ask yourself: do your clients need more features in a given product? What current struggles can you help them overcome? Testing, surveys, and actively seeking their feedback will help you get an answer.
Customers don’t feel valued
In the current financial environment, some of your customers may be facing tough decisions and in some cases products / services with subscription fees will be the first to go if they decide to cut down on costs. We have published a blog post that illustrates how anticipating problems and showing you value customers even if they decide to cancel can make a world of a difference.
Problems in service delivery
Products may arrive too late, may be too slow, or they may not meet customer expectations in one or more areas. A product may have an appealing unique value proposition, but if service delivery is too cumbersome, chances are that your clients will look for alternatives.
Unsatisfactory customer service
This may be caused by low staff motivation, lack of support, or problems in your corporate culture. To tackle this, make sure that your customer success team has the tools, resources, and mindset needed to improve customer satisfaction levels.
Loyalty is not rewarded
Loyalty is likely to follow if a product or service delivers what clients want, but it shouldn’t be taken for granted. Recognition and appreciation are key in boosting customer retention rates, and this often translates into developing customer loyalty programmes and choosing the type of reward that resonates with client needs.
Every team member in every department should understand that achieving a strong ARR is a collaborative effort. Your customer success team should be working alongside sales, marketing, and other departments whose work has a direct impact on subscription sales and retention rates.
Making the wrong decisions or the right decisions at the wrong time
This is applicable to critical business decisions such as scaling up business operations, expanding recruitment efforts, or diversifying your product offer. Making these decisions at the wrong time may lead to a decline in ARR revenue because in many cases, these decisions are made looking exclusively at MRR growth, instead of keeping the bigger picture in mind.
Poor understanding of market trends
Keeping a subscription business afloat is a challenge that requires ongoing attention to internal and external trends. If your leadership team has a poor knowledge of market trends, disruptors, and why competitors are being successful, you’ll inevitably lose ground and face declining ARR. This problem is common among companies that were first-to-market and have since become complacent. If this is your case, you’ll need to gravitate towards a fast-to-market approach.
When it comes to getting leads to your website, you may be tempted to think that the more the better. But quantity will not have any tangible effect on revenue if you don’t focus on attracting leads with highest conversion value.
An unbalanced approach to customer acquisition
Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLV) are important metrics to track. But if CAC expenditure is equal or higher than CLV, the operational costs of your SaaS business can soon become unsustainable and lead to shrinking ARR.
What Can You Do To Fix Declining ARR?
Declining ARR revenue is a metric you shouldn’t ignore, since it’s closely related to business momentum and survival. Taking prompt action is critical, and there are two solutions to consider depending on the reasons behind declining ARR:
- If you’re seeing a decline in sales, you can benefit from adopting a more strategic approach to filling your sales pipeline. This is what a customised SaaS Sales Funnel can do for you: enable consistent and faster results by implementing a tailor-made high-performance funnel that targets decision-level prospects.
- If declining ARR is due to operational problems, you’ll want to consider making growth-focused adjustments. Our Inbound Marketing GamePlan provides SaaS businesses with an action-based and data-driven roadmap to achieve this.